FINANCIAL REVIEW

ECB QE

Sinclair Noe — January 22, 2015

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DOW + 259 = 17,813
SPX + 31 = 2063
NAS + 82 = 4750
10 YR YLD + .04 = 1.90%
OIL – 1.24 = 46.54
GOLD + 9.20 = 1303.10
SILV + .20 = 18.41

The European Central Bank has launched a quantitative easing program, which together with existing programs, will pump €60 billion per month into the Eurozone economies through the purchase of public and private securities, mainly government bonds. The QE program will run through September 2016 with a total price tag of €1 trillion (or $1.3 trillion dollars).

So, it’s a big money printing, QE party for the Eurozone, except for Greece. The central bank effectively shut Greece out of the bond buying until July, and only then if Greece passes a review of its current bailout program. That program is heavy on debt reduction and austerity. The country’s existing program of financial support expires at the end of February. The government will run out of money by June without further aid.

Greece holds elections on Sunday. The Syriza party is expected to win the election. Syriza would like to default on existing debt and scrap the current bailout program; essentially challenging the status quo of fiscal austerity policy. What happens if Syriza wins the election on Sunday? Well, they will probably claim that fiscal austerity has contributed to the despair and poverty of Greece and created a humanitarian crisis in the country, deserving of special assistance.

Greece is an extreme case, as its output has fallen 30 percent since 2008, but not a unique case, as peripheral Europe has suffered disproportionately in the post-global financial crisis era. Syriza has already called for a “European debt conference” to renegotiate the current loan debt. No telling what could happen with such a conference; they might find a sympathetic ear or not; they might repudiate their debt, or not. Greece is unlikely to exit the Eurozone, but the Eurozone might try to kick them out, or not. The real risk for the EU is not a Syriza win, nor a Greek exit, but that EU policy fails to evolve and adjust to the shifting political will of its citizens, particularly now that populist and anti-establishment parties are finding their political voice on national and EU levels of representation. It’s not just Greece that has suffered under austerity.

Is Euro QE bearish for the US? It is widely expected that Euro QE will push down the value of the euro currency, which means European exports would be cheaper for US buyers, and in turn could negatively impact US exports which are already feeling the sting of a strong dollar. Further, cheaper euro exports might have a deflationary or disinflationary impact on the US.

Or, is Euro QE bullish for US? When central banks print money, it inevitably sloshes outside of its own borders, and Britain and America are far more attractive homes for that cash right now than Greece or Italy. There are not many investment opportunities in Italy or Greece or Portugal right now. The US has the best prospects of any of the developed nations right now. The economy is expanding at a healthy rate and jobs are being created. The yield on US Treasuries is higher than the yield on sovereign bonds from Germany, France, or Italy – plus the dollar is moving higher. The S&P 500 moved to its highest level since December 30, and above its 50 day moving average. Wall Street loves free money and they don’t particularly care where it comes from.

And then the big question is will ECB QE work? Probably not. The ECB and the Euro Union have been really bad at handling fiscal and monetary policy. What has evolved in the EU region is a crisis between divergent economies, between stronger and weaker member states, roughly divided between core and periphery, resulting in a two-tiered European Union composed of creditors and debtors. Weaker countries are now locked-in to a subjugated relationship with the core. The core continues to demand more austerity, even though it has been a horrible failure, and the periphery is finally realizing that the rent is just too damn high. The current manifestation of this inequity sees Germany keeping a tight rein on ECB policy by pressing Greek debt service beyond the limits of social tolerance.

In 2011, the ECB raised interest rates; compare that to the US Fed starting another round of QE. And then they waited, probably for far too long, to do anything at all. Euro monetary and fiscal policy has been out of step and off base; treating debt and the possibility of inflation as the overwhelming risks, and whistling past the graveyard of deflation and unrelenting weakness and lack of demand.

Today, Societe Generale issued a report saying that the QE plan would likely only add about 0.2% to 0.8% to inflation and overall GDP over the next 2 years; for Eurozone inflation to get anywhere close to a 2% target, the QE would need to be 2 or 3 times bigger. Of course, if the ECB tried to expand the bond buying program to €3 trillion, they would run out of sovereign bonds to buy. And that gets back to the whole problem of QE in the first place; it pumps a whole lot of money into the wrong places. Rather than investing in things like infrastructure or new technology, it pumps money into the financial market casinos.

Of course, most problems seem to be resolved in the richness of time. Deflation and inflation ebb and flow, and eventually the Eurozone will do the right thing, or at least something that resembles the right thing. Expect a lot of volatility before that time. For now the European Central Bank’s QE scheme might be the best hope to return growth to the Eurozone.

Let’s check today’s economic data. US house prices rose a seasonally adjusted 0.8% in November, according to the Federal Housing Finance Agency house price index. October’s gain was revised to 0.4% from 0.6%. Compared to November 2013, prices were up 5.3%, or 4.5% below the April 2007 peak.

The number of people who sought new unemployment benefits in mid-January fell by 10,000, but the level of applicants remained above 300,000 for the third straight week for the first time since July in what’s likely a reflection of post-holiday layoffs. Initial jobless claims declined to 307,000 in the week ended Jan. 10.

The World Bank has issued a forecast on commodity prices; they say all 9 commodity price indices will be down, across the board. We already know that oil prices are down about 55%. The steep decline in oil and related energy products is driving down the cost to extract other commodities. Also a drop in biofuel production is weighing on agriculture prices.

ConvergEx Group polled 306 investment professionals asking, among other things, what oil price would show that a global recession was inevitable; in other words, how low can we go without hurting the economy. The most common answer was $30 a barrel, from 26% of respondents, with $35 a barrel being the second most common answer (16% of respondents). About 68% of the respondents said oil hasn’t reached a bottom yet, and only 20% think it already has. About 66% said current prices are a positive to the US economy.

The US Energy Information Administration said crude inventories rose by 10.1 million barrels on the week ended Jan. 16. Moreover, at 388 million barrels, US crude oil inventories are at the highest level for this time of the year in at least the last 80 years. The oversupply in oil markets is expected to persist through at least the first half of the year, and there’s no indication OPEC or producers outside the cartel would move to cut down on output. Several energy companies have announced capital-budget cuts for this year and some have announced layoffs due to the lower prices, but not significant production cutbacks, at least not yet.

In other news, after almost eight months of constant fighting between Ukrainian troops and Russian-backed separatists, the Ukrainian military lost control of the Donetsk Airport.

Fighters loyal to a renegade general in Libya just seized a Central Bank facility in the coastal city of Benghazi that houses a reported $100 billion in cash and gold.

The president of Yemen quit today, under pressure from rebels holding him captive in his home, severely complicating American efforts to combat al-Qaida’s powerful local franchise and raising fears that the Arab world’s poorest country will fracture into mini-states.

Meanwhile, about 2,500 mainly rich people have gone to Davos Switzerland to attend the World Economic Forum. A bunch of not so rich journalists have followed them. Maybe you’ve seen the pictures and interviews on CNBC or some other network. The interviews take place on a patio with snowy hills in the background; everyone is bundled up in big jackets; it looks cold. For some reason they couldn’t find an indoor location with a picture window.

One of the attendees is Jeff Greene; he’s a billionaire money manager from Florida, and he said, “America’s lifestyle expectations are far too high and need to be adjusted so we have less things and a smaller, better existence. We need to reinvent our whole system of life. Our economy is in deep trouble. We need to be honest with ourselves. We’ve had a realistic level of job destruction, and those jobs aren’t coming back.”

Greene flew to Davos on a private jet with his wife and kids and 2 nannies.

Time for today’s edition of “Banks Behaving Badly”. US and state regulators ordered Wells Fargo and JPMorgan Chase to collectively pay $35 million to settle charges that they participated in an illegal marketing kickback scheme with a now-defunct title company. The CFPB said the former title company, Genuine Title, would give the banks’ loan officers cash, marketing materials and other consumer information in exchange for business referrals; essentially the bank loan officers were trying to make a quick buck rather than treating customers fairly.

The Barclays dark pool drama continues after NY AG Eric Schneiderman accused the British bank of defying subpoenas seeking the testimony of two executives. Previously, the AG accused the bank of false representation and favoring high frequency traders over other investors in its dark pool. Barclays says Schneiderman is overreaching, but it will “continue to seek to cooperate” with the lawsuit.